Canada's Mortgage Insurance Risk Needs a Better Backstop
Toronto - Canada's mortgage insurance risk needs a better backstop fund, according to a new report released today by the C.D. Howe Institute. In "Mortgage Insurance as a Macroprudential Tool: Dealing with the Risk of a Housing Market Crash in Canada," authors Thorsten V. Koeppl and James MacGee suggest an era of steadily rising house prices and high mortgage debt warrants concern over the potential exposure of Canada's mortgage insurance system and taxpayers.
"While Canada has not experienced a US-style housing bust, house-price declines ranging from 30 percent to 50 percent have occurred in many other OECD countries since 1970," explains Koeppl. "Our analysis indicates that a low-probability, but severe, housing crash could result in roughly $17 billion of losses for mortgage insurers, which is about 1 percent of GDP," he adds.
Mortgage insurers' reserves currently exceed the minimum required, but such losses would leave the federal government with a bill of up to $9 billion to recapitalize mortgage insurers, should Ottawa choose to do so. Such a crisis would also trigger the 10 percent deductible on the government guarantee of the mortgage insurance policies issued by potentially insolvent private insurers. Anticipation of deductible losses could also trigger a "run," where lenders avoid dealing with private insurers, which could result in restricted access to finance for homebuyers, further destabilizing the housing market.
The Canadian mortgage insurance system is architecturally sound, say Koeppl and MacGee, and they recommend three incremental reforms that would reposition the system to better address the risk of a severe housing crash:
Redesign the government backstop to focus on events that include a severe housing crash along with rising unemployment. The backstop should be organized as a standalone fund that accumulates reserves in advance of a housing crisis, up to a target level, and has the capacity to borrow against future revenue if needed.
The Financial Institutions Supervisory Committee (FISC) should oversee the backstop fund, particularly its pricing policy, accumulation of reserves and target level for reserves.
The mortgage insurance backstop should be available only for the residential ownership market.
Guided by financial stability considerations, the report's recommendations largely build on recent federal measures to refine how it regulates and backstops mortgage insurance. "A well-designed mortgage insurance system is an essential macroprudential tool to manage the Canadian economy's exposure to large risks resulting from housing market cycles," concludes MacGee.